Obamacare: Permanent Problem for Health Insurers? - Industry Outlook

The healthcare legislation has undoubtedly altered the regulatory landscape in ways that is not beneficial private health insurers' bottom lines. But calling it a permanent drag would be an overstatement, as well.

Health insurers are non-cyclical, recession-resistant companies that provide a necessary service and are therefore not affected by economic cycles to that same extent as other sectors. But there are nevertheless risks that will weigh on results and stock market performance. The focus of this write-up is to spotlight the headwinds facing the industry; an earlier write-up in this space had the opposite focus.

Restriction on Players

Numerous Affordable Care Act (ACA) mandates that have been chalked out for insurers place restrictions on the players. Here are those with the greatest impact:

The act imposes strict limitations on insurers' price discrimination ability: The ACA allows insurers to only charge limited differential prices on certain factors. Although insurance companies can rate on age, the oldest adult in the risk pool cannot be charged more than three times as much as the youngest adult. Similarly, smokers can be charged no more than 1.5 times as much as non-smokers. The end price discrimination is intended at creating healthy competition between players.

Medical Loss Ratios cap insurers' profits: Medical Loss Ratio MLR is a measure of the share of premiums that an insurer actually spends on delivering care to policyholders, rather than on administrative costs, marketing and profits. The minimum MLR mandate established by the ACA aims to control the portion of premium that goes toward non-medical expenses such as administration, marketing, overheads and profits. The MLR is set at 85% for the large group market and at 80% for the small group market.

This provision will lead to limited bottom-line growth as carriers will be forced to spend a minimum amount on the insured. Failure to abide by the MLR rule will force carriers to rebate the excess cash back to the insured or to lower the premium.

Insurers cannot reject coverage on the basis of pre-existing disease: Earlier, it was common among insurers to deny coverage to applicants with a pre-existing disease or condition. As the insurers sieved the healthy population and rejected the less favorable, claim payments were kept at bay. With this new policy, insurers must cover individuals irrespective of their pre-existing condition. This would lead to lower profit per policy as previously individuals with pre-existing conditions were charged two to five times higher than those with average health.

State-based rate reviews for unreasonable increase in insurance premium: Increase in premium of more than or equal to 10% is subject to expert evaluation to ensure reasonable cost assumption and solid evidence. This mandate put a check on unbridled rate increases by players.

Growing consumer power: Until the passage of the health reform act, the insurance companies had an upper hand in choosing whom to provide coverage and the consumer (the person receiving the healthcare) had no active role in the decision-making process. But now the trend has changed. Consumers' use of increased purchasing power and access to information to take health care decisions is one of the major threats to insurers.

Prior to reform, big insurers dominating large markets hardly ever bothered to provide even the basic information to consumers, such as the performance of health insurance policies, procedures to claim, the size of the provider network and cancellation processes. But now customers demand transparency, value, and convenience, which has left insurers grappling for innovative ways to satisfy these unmet needs. These new missions, however, are not going to be easy to execute.

Global economic woes and regulatory challenges: A fragile global economy presents a headwind for insurers looking to expand their international operations. One of the largest insurers, UnitedHeath Group Inc. UNH recently made an acquisition to reap benefits from the Brazil market but is now facing slowing growth rates in that country.

In the case of India, which remains one of the most profitable opportunities for the insurers, the regulatory environment has proved extremely challenging. China -- which merits the highest risk-adjusted opportunity ranking, largely because of its immense scale -- poses significant investment restrictions for foreign insurers entering and operating in this market.

While the above discussed factors might deeply affect the players in the industry, we do not recommend selling any stocks -- UnitedHealth Group Inc., WellPoint Inc. WLP, Aetna Inc. AET, Molina Healthcare, Inc. MOH, Humana Inc. HUM and Health Net, Inc. HNT -- under our coverage. None of these holds a Zacks Rank #5 (Strong Sell) or even a Zacks Rank #4 (Sell).

Bottom Line

The changed regulatory landscape has undoubtedly created hurdles for industry operators that will weigh on profits and margins going forward. But it is hardly the unmitigated disaster that some industry players make it out to be. But beyond the ACA, the investment appeal of the space also reflects its perceived defensive and counter-cyclical orientation, which is very valuable in the current uncertain backdrop.

Bottom line: there are numerous challenges for the group. But there is no shortage of opportunities either.

Check out our latest Health Insurance Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector now.